Efficient Markets Theory Gone Awry: Buffalo Wild Wings vs. Chipotle Mexican Grill

Includes: BWLD, CMG
by: Tyler Mayoras

Next time you are at a cocktail party and someone starts expounding on efficient markets theories, you can counter with two words that perfectly rebut the efficient markets theory --- momentum investing.

Case in point this morning: Buffalo Wild Wings (BWLD) vs Chipotle Mexican Grills (NYSE:CMG). I have owned BWLD since August 2006 and I really like the Company and its growth characteristics. Since purchasing the shares in 2006, the Company has provided a wild ride, I have seen the gain in the stock increase to 150%, drop to 74%, increase to 100%, drop to 40% -- but I remain unfazed.

Through that entire period the company has continued growing earnings by 20%-25%. What prompted the change in price? Analyst expectations!

During the past 12 months, they have exceeded expectations in 2 of those quarters, met expectations in one quarter and missed expectations by $.02 in the latest quarter. As you might guess, the gain varied depending upon the earnings relative to expectations.

Now is anything different at the company throughout this period? No, absolutely not. Same company, same management, same historic growth and same long-term growth prospects. But Mr. Market has arbitrarily set the price too high at times and too low at others. That is not an efficient market.

What's more, lets look at BWLD vs. CMG. Admittedly, CMG has done a better job at managing analyst expectations and continually exceeding those expectations. Momentum investors love that stuff. They often do not even look at a company's fundamentals -- they merely watch earnings vs. expectations and companies with "exceeding trends"...until the company meets or misses expectations and then they all jump ship at the same time.

This morning BWLD was bit by missing while CMG continued to gain from exceeding expectations.

Looking at valuations, the story is entirely different.

At $30 per share, BWLD trades at 25x 2007's earning expectations (Dec. YE) and 22x 2008's expectations. The Company's earnings are expected to grow to $1.42 in 2008 for growth of 22%. The PEG Ratio (price to growth) is basically 1:1 -- very low for an above average growth company.

At $138 per share, CMG trades at 68x 2007's earning expectations (Dec. YE) and 54x 2008's expectations. However, they have exceeded each of the past 4 expectations by 17%-35%, an average of 22%, so lets bump the 2008 expectation of $2.54 up by 22% to $3.09. Then the PE is 44x 2008's upwardly revised estimate. The earnings are expected to grow at 25% over the next year for a PEG of 2.16x actual estimates. If we use the 22% earnings surprise estimate for 2008, then the PEG is closer to 1:1.

Basically CMG is priced to continue to exceed expectations by 22% each quarter, and when they miss, the stock will be slammed. And they will miss eventually, unless analysts are completely stupid, because they will begin to expect the higher earnings and price it in. Remember CMG has only been public for about 6 quarters so the analysts are still learning.

Now looking objectively, which company would you rather own, the one that is priced at a 1:1 PEG ratio only if they continue to exceed expectations by at least 22%, or the Company priced at a 1:1 PEG ratio today on actual reality?

I am looking to buy a bit more BWLD today or over the next week when it hits my limit orders.

Disclosure: author is long BWLD.

BWLD-CMG 1-yr. chart: